How EMI Is Calculated and Whether You Should Prepay Your Loan
An EMI (equated monthly instalment) is a fixed monthly payment that repays a loan, with interest, over a set number of months. Banks in India calculate it on a reducing balance: each month you pay interest only on the principal still outstanding. Understanding how that works explains why your first-year statement shows so little principal repaid, and why a prepayment early in the loan saves far more than the same amount paid later.
This guide works through the formula with real numbers in rupees, then compares the two ways banks let you apply a prepayment.
The reducing-balance EMI formula
The standard formula uses three inputs: the principal P, the monthly interest rate r (annual rate divided by 12, as a decimal), and the number of monthly instalments n.
For a ₹20,00,000 home loan at 9% a year for 20 years: r = 0.09 / 12 = 0.0075 and n = 240. (1 + r)^n = 1.0075^240, which is about 6.0092. EMI = 20,00,000 × 0.0075 × 6.0092 / 5.0092, which works out to about ₹17,995.
Over 240 months you pay ₹17,995 × 240, roughly ₹43.19 lakh, of which about ₹23.19 lakh is interest. Total interest exceeds the amount borrowed. That is normal for a 20-year loan at this rate, and it is the number to keep in mind when deciding whether to prepay.
EMI = P × r × (1 + r)^n / ((1 + r)^n − 1)
P = 20,00,000 r = 0.09 / 12 = 0.0075 n = 240
EMI ≈ ₹17,995
// Same formula in a spreadsheet:
=PMT(9%/12, 240, -2000000)Why early EMIs are mostly interest
Each EMI is split in two. Interest for the month is the outstanding balance times r; whatever is left of the EMI reduces the principal. In month 1, interest is 20,00,000 × 0.0075 = ₹15,000, so only ₹2,995 of your ₹17,995 goes to principal.
Across the first 12 months you pay about ₹2.16 lakh in EMIs, but the balance falls only from ₹20,00,000 to about ₹19,62,546. Roughly ₹1.78 lakh, or 83% of what you paid, was interest. The split slowly improves each month as the balance falls, and in the last few years almost the whole EMI is principal.
This is the amortisation schedule, and it is why a loan statement after three years can look discouraging. It is also the key to prepayment: money paid towards principal early removes interest that would otherwise have been charged on it for many years.
Prepayment: reduce tenure or reduce EMI?
When you prepay, most lenders ask whether to keep the EMI and shorten the tenure, or keep the tenure and lower the EMI. Using the same loan, suppose you prepay ₹2,00,000 right after the 12th EMI, when the balance is about ₹19,62,546 and 228 months remain.
- No prepayment: remaining interest over 228 months is about ₹21.40 lakh.
- Reduce tenure, keep EMI at ₹17,995: the loan closes in about 178 months instead of 228, 50 months (over four years) sooner. Remaining interest falls to about ₹14.32 lakh, a saving of roughly ₹7.08 lakh.
- Reduce EMI, keep 228 months: the new EMI is about ₹16,161, a monthly saving of around ₹1,834. Remaining interest falls to about ₹19.22 lakh, a saving of roughly ₹2.18 lakh.
Reading the comparison
Reducing tenure saved more than three times as much interest from the same ₹2 lakh. That is not a quirk of these numbers; it holds generally, because keeping the EMI high means principal keeps falling faster for the rest of the loan. If your aim is to pay less interest, choose reduced tenure.
Reducing EMI still has a place. It frees up monthly cash flow, which helps if your income is irregular, if you are about to take on another commitment, or if you want a buffer. Some borrowers split the difference: reduce the EMI, then invest or keep the monthly saving as an emergency fund.
Timing matters as much as the choice. The same ₹2 lakh prepaid in year 15 saves far less, because only a few years of interest remain on it. If you plan to prepay, earlier is better.
Should you prepay at all?
Prepaying is effectively a guaranteed, risk-free return equal to your loan rate. Whether that beats the alternative depends on your situation. Work through these questions in order:
- Emergency fund first. Keep six months of expenses, including EMIs, in liquid savings before prepaying. Money put into a loan is hard to get back out.
- Higher-cost debt first. Credit card balances and personal loans usually cost far more than a home loan. Clear them before prepaying a cheaper loan.
- Compare post-tax returns. A home loan at 9% is a 9% guaranteed return when prepaid. A fixed deposit at a lower rate, taxed at your slab, rarely beats it. Equity may beat it over long periods but with real risk.
- Account for tax benefits. Under the old tax regime, interest on a self-occupied home loan is deductible up to ₹2 lakh a year, which lowers the effective rate; under the new regime that deduction is not available for self-occupied property. Check the current rules or ask a tax adviser for your case.
- Check prepayment charges. RBI rules do not allow banks and NBFCs to charge prepayment penalties on floating-rate loans taken by individuals for non-business purposes. Fixed-rate loans may carry a charge, often a percentage of the amount prepaid; read your sanction letter.
- Ask for a revised schedule after every prepayment and confirm that the lender applied it to principal and to the option (tenure or EMI) you chose.
Run your own numbers
Plug your loan amount, rate, and tenure into the Neemtools EMI Calculator to get the EMI and total interest, and add a part payment to see how much tenure and interest it removes. The Loan Calculator is handy for quickly comparing offers from different lenders at different rates. If your bank changes a floating rate, recalculate: most lenders keep the EMI unchanged and extend the tenure when rates rise, which can quietly add years to the loan unless you ask for the EMI to be revised instead.